Tax Bait for Trophy Companies

5/1/2015

STATE LEGISLATURES MAGAZINE | MAY 2015

Big corporations have been lured by tax incentives to expand in or locate to a state. Are they worth it?

By Jackson Brainerd

Nevada scored a big win last fall when, after a five-state bidding war, Tesla Motors picked it as the site for its new $5 billion battery manufacturing “giga-factory.”

The Legislature unanimously approved a $1.3 billion tax incentive package to lure the 12-year-old Silicon Valley, electric carmaker in exchange for the promise of creating 20,000 new jobs and generating $100 billion in state economic activity, according to the Governor’s Office of Economic Development. Some people called the deal the biggest thing since the Hoover Dam.

Illustration of sharks swimming for baitTime will tell if Nevada’s gamble pays off.

Improving the business climate and spurring economic growth are top priorities for most state legislators. And although many economic development strategies—such as income tax cuts and workforce training—can get mired in partisan rhetoric, megadeals offering substantial tax incentives to single, lucrative corporations, enjoy unusual bipartisan support. And the bait is increasing.

Of the 20 largest incentive deals ever, all valued at $800 million or more, 19 occurred since 2000 and 11 since 2010.

Economists’ Gloom

Today, every state offers at least some sort of tax incentive for businesses. Yet, despite lawmakers’ enthusiasm for corporation-specific incentives, many economists, experts and other observers, from the left to the right, doubt they are an efficient use of public money.

Nevada’s partnership with Tesla came under fire from the conservative Nevada Policy Research Institute and the liberal Progressive Leadership Alliance of Nevada. Both questioned whether the new legislation would ever benefit Nevada’s taxpayers.

In its recent report on 2015 State Business Climates, the more conservative Tax Foundation cautioned: “Economic development and job creation tax credits complicate the tax system, narrow the tax base, drive up tax rates for companies that do not qualify, distort the free market, and often fail to achieve economic growth.”

The more liberal Center on Budget Policy and Priorities concurred, and called economic development tax subsidies “relatively ineffectual, potentially counterproductive, and not cost-effective incentives for job creation and investment.”

Those who oppose these large tax incentives generally consider them to be a zero-sum game for the nation, as there is no net economic gain when one state forgoes revenue to coax a business away from another state. In fact, a report published by the Journal of American Planning Association estimated that incentive programs cost state and local governments about $40 billion to $50 billion a year.

So what gives? Why is there this disconnect between fiscal theory and practice when it comes to this kind of incentive?

Absence of Evidence

For proponents of these corporation-specific incentives, the debate over whether incentives are theoretically sound fiscal policy is beside the point. They believe they are absolutely necessary. If a state does not offer incentives, out-of-state businesses looking to relocate will find one that does; or worse, the major employers that are already in-state will leave for greener pastures. It’s a classic “race to the bottom,” critics say, and states don’t have much of a choice in the matter.

A report prepared for the South Carolina Chamber of Commerce on the tax incentives received by Boeing, states it this way: “While some nonpractitioners argue on theoretical bases that it would be better for all and more economically efficient if South Carolina and other states did not provide incentives, the real world dictates otherwise. If South Carolina were to do away with all economic development incentives, the state would be at a great disadvantage with its competitors in the Southeastern United States.”

Whether incentives are actually do-or-die policy is difficult to prove; there isn’t much evidence either way. “There is very little work looking at the overall revenue impact of economic development incentive systems, and the work that does exist uses widely different methodologies,” according to the Journal of American Planning Association. The rise in megadeals is troubling primarily because states don’t have a firm grasp of how effective these nine-to-10-figure public subsidies are at creating jobs.

“No state regularly and rigorously tests whether those investments are working,” states a 2012 report by The Pew Charitable Trusts. Nor does any state require lawmakers to “consider this information when deciding whether to use them, how much to spend, and who should get them,” the report says.

Case in point: In a recent study commissioned by Louisiana on the effectiveness of its tax system, analysts claimed the state had been “flying blind” by granting tax exemptions to corporations without tracking their effects on state revenue or economic growth.

Several notable tax deals illustrate what states have (or haven’t) done to ensure incentives produce a bang big enough to justify the megabucks that went into them.

Arizona, California, New Mexico and Texas competed with Nevada for the Tesla plant. Nevada’s deal authorizes 100 percent sales tax abatements for 20 years, 100 percent abatements of property and employer excise (payroll) taxes for 10 years, and nearly $200 million in credits for hiring and capital investments. If the project fails to make a sufficient investment in the state or reach employment targets, the Nevada legislation allows for a clawback of tax credits or a repayment of abated taxes.

Lessons Learned, From Boeing, Intel, Nike and BMW

Boeing is the undisputed champion in the mega-incentives game. In 2003, Washington granted it a $3.3 billion incentive package, the largest ever at the time. Ten years later, after Boeing threatened to leave for a second time, Washington gave the aerospace giant another $8.7 billion in tax breaks to ensure it would stay grounded and build its 777X manufacturing plant in the state.

Washington, however, did not hedge its bets, and did not include clawback provisions requiring Boeing to bring more jobs to the state. Since signing the historic incentive package, Boeing has laid off 1,700 workers. While this serves as a cautionary tale, it doesn’t necessarily offer a rebuke of tax incentives in general, since Boeing currently employs more than 80,000 state residents.

The computer chip giant Intel saved some $2 billion in taxes through a deal it struck with New Mexico in 2004. The state issued $16 billion in tax-exempt industrial revenue bonds to Intel to invest in its plant in Rio Rancho on the condition that 60 percent of new hires be state residents. Then in 2013, Intel successfully lobbied the state for a more favorable corporate income tax formula (through a single sales factor apportionment). How much Intel saved on its tax bill is not known, however, since corporate tax information is confidential in New Mexico.

The New Mexico deal did not hold Intel accountable for the number of jobs created: There were no job or wage targets and no clawbacks to ensure the state could recoup losses if Intel didn’t deliver. Six months after receiving the special tax allowance, Intel cut 400 jobs at its Rio Rancho plant. Blaming the state’s lack of “a sufficiently well-trained workforce,” Intel also failed to hire at least 60 percent from within the state on several occasions. The penalty: $100,000.

In 2012, after NIke threatened to move elsewhere, the Oregon Legislative Assembly convened for an unusual special session following a single day of public testimony. The purpose was to pass an agreement ensuring that Nike would be taxed using the single sales factor apportionment method for the next 30 years. In return for the $2 billion tax break, Nike was to invest $150 million in a capital project that would produce 500 jobs.

Former Oregon Senator Bruce Starr (R) contends the deal actually “didn’t cost the state a dime. All the Legislature did for Nike was provide certainty as it related to their current tax situation.” As long as Oregon does not change its use of a single sales apportionment, the deal won’t give Nike anything it doesn’t already have, Starr says, and ensures a large in-state investment from a corporation that employs 8,000 Oregonians.

On the other side of the country, South Carolina pounced when the German automobile company BMW announced it was searching for a low-cost site to build its three-series models back in 1992. The state spent $36.6 million to buy private properties along an appealing 1,000 acre stretch of I-85 that it then leased to BMW for $1 a year. The state also agreed to train BMW’s entire workforce through the state’s technical schools.

The total package cost the state about $150 million, but no one questions that the company has transformed South Carolina’s economy. An automotive plant can have a dramatic effect on any state’s job opportunities and income levels, and BMW has proved that in South Carolina. Bloomberg Businessweek called it vital to the rise of the new automotive “Boom Belt” in the Southern states.

The state has given BMW a total of seven incentives, including another megadeal worth $103.5 million in 2002. Currently, the automaker directly employs 7,654 workers in the state and spends $677 million on wages and salaries, according to a 2014 economic impact study by the University of South Carolina’s Moore School of Business. The BMW jobs tend to be high wage, skilled positions. BMW’s extensive regional supplier network and large direct payroll helps spread income and employment opportunities throughout the state’s wider economy, and it looks like that influence will continue. BMW recently invested another $1 billion in its plant to build two of its new X-series vehicles.

Counting the Costs

There is no question that tax incentives can ultimately create jobs and revitalize a local economy, but are they worth the cost? In a study of 240 subsidies, each $75 million or more, The Good Jobs First group found that the average job created by one of these megadeals had a price-tag of $456,000.

“At that cost, no state or locality is going to break even on a deal, so we think states are overpaying,” says Greg Leroy, the organization’s executive director.

Joe Henchman of the Tax Foundation argues that because the vast majority of business decisions that create jobs “are based on things like the education system, proximity to markets, workforce levels and state tax systems, a state would be better off making sure it’s competitive in one or all of those things than just offering good deals.”

Acquiring large-scale investments from lucrative companies may scream “prosperity for all,” but even the most successful large corporate catches produce only a small percentage of the jobs most states need.

The benefits of a broad-based approach to economic development are apparent. Economist Jeremy Horpedahl of Buena Vista University in Iowa estimated that if Nebraska diverted the $2 billion it spends annually on incentives to lowering tax rates overall instead, the average family would save $3,200.

Critics of megadeals for trophy companies argue they are inequitable; that is, they violate the principles that tax burdens should be distributed proportionally based on the ability to pay (vertical equity), and that those with similar incomes and assets should pay about the same amount of taxes (horizontal equity). By providing tax exemptions or assurances to single corporations, opponents say, tax burdens shift onto the backs of the rest of the tax-paying community, putting the benefitted corporation’s competitors at a disadvantage.

Economist David Brunori notes that, whether real or perceived, “Differences in the taxation of equals shakes confidence in the tax system.”

A deal that narrows the tax base in this way is bound to receive criticism from taxpayers, especially if the deal lacks a sufficient amount of public input and debate. Nevada Senator Debbie Smith (D), NCSL president, believes engaging the public during the incentive deal-making process is essential, and should encourage lawmakers to “ask a lot of questions, give a lot of thought, and make sure there is a lot of accountability and reporting.”

An Incentive to Evaluate

Recently, the Governmental Accounting Standards Board proposed rules that would, for the first time, require state and local governments to divulge information about tax abatement agreements and report incentives as lost income in annual financial reports. This could be an important step in distinguishing the incentives that have been effective from those that haven’t been.

In the end, with more evidence at their disposal, lawmakers can make decisions on the best way to spur economic activity based on what the evidence proves. And although Pew’s research shows most states generally fail to evaluate incentive programs, some are moving in that direction.

Since 2012, legislators in 10 states and Washington, D.C., have passed laws to improve the evaluation of incentive programs. The New Jersey Legislature, in early April, passed a bill that is on the governor’s desk to require more comprehensive, regularly scheduled evaluations and to limit incentives to 10 years.

Other state bills require analysis on the degree to which incentives reward activity that would have happened anyway, the extent they benefited some businesses at the expense of others, how much of the benefit was kept in-state, and the impacts of the tax increases or spending cuts that funded the incentive. Legislators have introduced similar bills this session in Nebraska, North Dakota and Oklahoma.

“Since tax policy inevitably will be used to reach other policy objectives, lawmakers have a responsibility to ensure that the policy produces the intended effect and does so at a reasonable cost,”says NCSL’s tax expert Mandy Rafool. Evaluating tax incentives thoroughly and setting stricter requirements for recipients, not only makes good economic sense, it also adds transparency to a process that inevitably receives a lot of public scrutiny.

What Companies Want

“I never made an investment decision based on the tax code,” former U.S. Treasury Secretary and CEO of Alcoa, Paul O’Neill famously said. “If you are giving money away I will take it. … But good business people do not do things because of inducements.”

Although tax breaks undoubtedly sweeten any relocation deal, state and local taxes only account for about 1.8 percent of the cost of doing business, on average, according to Good Jobs First. Relocating businesses place an emphasis on the following attributes, according to Site Selection Online’s 2013 list.

  • A talented workforce.
  • Solid infrastructure with reliable access to electricity, gas, water, telecommunications, broadband, public transit.
  • An appealing living environment.
  • A concentration of related businesses or a specialization in a specific industry.
  • An active, large market.

     If a state does not have the knowledge base, skills or infrastructure to compete, some economists maintain that offering incentives essentially amounts to buying jobs for its citizens.

Defining Terms

TAX INCENTIVES | These may include breaks or credits on property, sales or corporate income tax, or issuance of tax-exempt industrial revenue bonds or low-cost loans. It is important to differentiate corporation-specific incentives (those that target one or several firms) from general tax policies that concern the broader business community. Although some states have incentive laws that apply to any business that meets certain statutory requirements, the requirements often benefit only the largest, most lucrative corporations.

SINGLE SALES FACTOR | The portion of a corporation’s profit subject to tax is typically measured in relation to its total property, payroll and sales in each state. The single sales factor allows a corporation’s income tax to be based solely on the share of its nationwide sales occurring in the state. For companies like Intel or Nike, which may have a significant presence in one state but make a majority of their sales out-of-state, this can significantly reduce their income tax liability.

THE CLAWBACK | These provisions are money-back guarantees governments insert into deals to allow them to recoup the incentive payment if the business fails to live up to its job creation or investment promises. Economists recommend that instead of just setting quotas they should require jobs to come with a living wage and benefits, or that the workforce comes from a specific region in need of an economic boost.

Jackson Brainerd is a research analyst in NCSL’s Fiscal Affairs program.

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